The strongest consensus view in the market is on a weaker dollar, even more so given the prospects of a dovish US Administration, with the announcement of names such as Janet Yellen to lead the Treasury and thus set the US’ ‘dollar policy’. What that policy will be under Biden we will only find out over the coming months, but we note that the world at large wants a weaker dollar and a stronger, more prosperous, rest of the world. Tactically, this backdrop will likely continue to create attractive trading opportunities in FX markets.

However, even though we can see the dollar continue to trade weak in the near term while risk assets power higher, on a slightly longer-term horizon, we find this narrative unconvincing. First, we expect this global recovery will be led by the US and China. This means that, at some point in 2021, it is likely that we start to see indications of a prospective ‘decoupling’ in global policies, as the US economy continues to lead the recovery. We are therefore very conscious of the risks that 10Y UST yields move higher, potentially towards 1.50 over the next six months or so. Even though some EM currencies might enjoy temporary support vis-à-vis the dollar, it is unlikely that we will see anything similar to past cycles of strong EM currency rally, when the Fed eased and when the global economy recovered.

At the same time, we remain sceptical of the upside to the euro. Mainstream strategists have remained exceptionally positive on the European economy ever since the announcement of the European Recovery Fund in the summer, with bullish expectations for European company earnings. However, as we have argued before, we struggle to see this as a watershed in European politics outside of such a crisis environment. Furthermore, we note that core inflation in Europe is hovering at a historically low level, even though no other large economy has experienced a similar collapse in inflation this year. The ECB has few degrees of freedom, and the appreciation in the euro has significantly tightened monetary conditions in the euro area, precisely the opposite of what policymakers intended.

Finally, it is likely that policy stimulus in the US will probably be leaning more on the fiscal side, while in the Eurozone it will be exactly the other way around, relying continuously on monetary, fuelling uncomfortable intra-eurozone credit questions. To sum up, though we concede that the euro can continue to benefit in the coming weeks from this very bullish market sentiment, we do not subscribe to the view of ‘exceptionalism’ of euro assets over the medium or longer terms.

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